A Wake Up Call On Social Security

December 19, 1999

The Social Security Advisory Board's Technical Panel on Assumptions and Methods recently released an official report criticizing the Social Security Trustees for presenting an "inadequate" and "misleading" picture of the long-term challenges facing the program. The Panel offers a number of sensible recommendations for focusing on the fiscal and economic bottom line. It also urges the Trustees to revise their assumptions about longevity, which are more conservative than those of most demographers and may greatly understate future costs. Along the way, the Panel examines the charge made by many defenders of the status quo that the Trustees are too pessimistic about economic growth, and thus about the system's long-term solvency. The Panel finds little evidence to support this claim. The Concord Coalition has long made many of the same points. We applaud the Panel for issuing a wake up call, and urge the Trustees to take it seriously.

Honest Accounting

Let's start with the recommendations for honest accounting. The Panel calls on the Trustees to: * Place less emphasis on actuarial balance and more on fiscal sustainability. The Panel points out that the official measure of Social Security's financial status-its 75-year actuarial balance-averages near-term surpluses with long-term deficits, and so says nothing about sustainability. While Social Security's actuarial balance over the next 75 years is projected to be a deficit of 2.1 percent of payroll, the program will be running an annual cash deficit of 6.4 percent of payroll by the end of that period. The Panel recommends that the Trustees pay equal attention to this long-term indicator. * Distinguish between what Social Security can pay and what it promises. The Trustees assume that future retirees will receive full current-law benefits even after trust-fund bankruptcy in 2034. In fact, unless taxes are raised, today's typical thirty-year olds will get just 72 cents of every dollar the Trustees say they will. To distinguish between what "the current system promises and what current law allows," the Panel recommends that the Trustees publish an alternative projection that assumes benefits will be cut when Social Security runs out of money. * Show projections of lifetime benefits and lifetime taxes. Although the Trustees include projections of yearly benefits in their reports, they say nothing about total lifetime benefits or total lifetime taxes. Without these numbers, readers have no way of knowing the true value of Social Security-or of comparing the deal that it offers successive cohorts of beneficiaries. * Publish estimates of Social Security's unfunded obligations, including its "closed group liability." This liability is the amount today's workers and retirees are due to receive in future benefits over and above current trust-fund assets plus what those same workers and retirees are due to pay in future contributions. At last count, it amounted to a staggering $8.9 trillion in present value terms. Social Security's closed group liability is a measure of the subsidy today's adults expect from future taxpayers-which means that it is also a measure of the cost of transitioning to a funded system. The Panel notes that private plans are required to report similar numbers, and recommends that the Trustees do the same. * Look at the impact of reform proposals on the budget and the economy, not just the trust funds. For the Trustees, all that matters is that a reform improves Social Security's actuarial balance-regardless of whatever else is happening to the federal budget balance or national savings. This narrow focus encourages shell games: Why cut benefits or increase contributions when crediting hypothetical budget surpluses to the trust funds does just as much to extend Social Security's solvency? The Panel warns against "free lunch" schemes-and recommends that the Trustees adopt a broader accounting framework that shows whether reform will really leave future generations better off.

Simple Prudence

Beyond honest accounting, the panel looked at the reasonableness of the economic and demographic assumptions underlying the Trustees' projections. It recommends one big change: that the Trustees significantly raise their expectations about future life expectancy. Currently, the Trustees project that mortality rates will decline more slowly in the future than they have in the past-in fact, at just half the pace they have declined since 1900. The Panel believes it is simple prudence to expect that the long-term historical trend will continue. If it does, life expectancy will rise to 85 by 2070, three-and-one-half years higher than the Trustees project. This change alone increases Social Security's cash deficit that year by roughly 2 percent of payroll. In recent years, the Trustees' longevity projections have been questioned by demographers, criticized by previous technical panels, and rejected by the Census Bureau. As we explain elsewhere, there is no justification for them. (See our alert of July 6, 1999.) Yes, conventional wisdom holds that the rate of mortality decline must eventually slow as medical progress pushes us up against the "natural limit" to the human life span. But a growing number of demographers question whether such a limit really exists. And even if one does, few think there's any evidence we are yet approaching it. The Panel notes that the overall rate of mortality decline in the United States has been remarkably consistent over time. It also cites international data showing that, far from slowing, the pace of mortality improvements at the oldest ages has actually been accelerating. Some biotech optimists are now predicting a life expectancy of 100 or more within a generation. But you don't have to agree with these visionaries to conclude that the Trustees are too conservative. As the Panel points out, accepting their projections means believing that American women will have to wait until 2026 to attain the life expectancy of today's Swedish women; until 2033 to match that of today's French women; and until 2049 to match that of today's Japanese women.

Mere Arithmetic

The Panel also dealt with the claim that the Trustees are inordinately pessimistic about future economic growth-and that with more realistic assumptions, the Social Security cost challenge evaporates. It is true that the Trustees project that real GDP will grow more slowly in the future than it has in the past. But this is mere arithmetic, not pessimism. (See our alert of March 18, 1998.) What the critics forget is that GDP growth depends on workforce growth, and that this will fall to near zero when Boomers start retiring. From 1973 to 1998, the U.S. workforce grew by 1.7 percent per year; by the 2020s, it will be growing by just 0.2 percent per year. Thus, given the demographics, it would fly against all logic if GDP growth did not slow. A more legitimate question is whether the Trustees are too pessimistic about the growth in productivity, or output per worker hour. The Panel finds little reason to think so, although it recommends that they nudge up their long-term growth rate from 1.3 to 1.4. The positive impact of this adjustment on Social Security's actuarial balance is so underwhelming that it is canceled out by another technical change the Panel recommends: lowering the real interest rate from 3.0 to 2.7 percent. As it turns out, the Panel's recommendation would put the Trustees right in line with the record of the last quarter-century. The comprehensive revision of the National Income and Product Accounts released last month shows that output per hour for the total economy grew at an annual rate of 1.4 percent from 1973 to 1998. In the future, the Trustees' assumption may have to be raised further. Since 1995, productivity has unexpectedly surged. Some are suggesting that this heralds the arrival of a "new economy" in which information technologies and globalization will lead to dramatically and permanently higher rates of productivity growth. But keep in mind, even if the higher productivity growth proves lasting, we're still talking about a slower rate of GDP growth. And even more important, the extra productivity growth won't do much to reduce Social Security's burden. Yes, when productivity goes up, average wages go up-and this adds to tax revenues. But when average wages go up, average benefit awards also go up-and this adds to program outlays. Practically, the only way to get big savings from higher productivity is to sever the link between average wages and new benefit awards. The United Kingdom did this under Maggie Thatcher, and the reform has stabilized its long-term pension outlook. Concord does not necessarily recommend that America follow suit. But without change in the program, higher productivity growth alone cannot possibly save Social Security.

Clutching at Straws

Again, the Panel is to be commended for its sensible recommendations-and for its courage in challenging the status quo. The Panel's report helps focus Americans on the bottom line. Today's prosperity, while welcome, will not spare us from making tough choices about senior entitlements. It's time we stopped clutching at straws-and put Social Security at the top of the agenda where it belongs.